To Borrow Or Not To Borrow?

In the context of property investment, ever wonder why entrpreneurs borrow money from the financial institutions to finance their purchase of properties? High net worth properties are always a good investment because among others, it hedges the rising cost of living or the inflation rate.Let us look at the two examples below:

Scenario 1:

Say, i want to purchase a condo worth RM 1,000,000 in the vicinity of Mon't Kiara. Let's assume that i would expect a rental income of RM 5,000 monthly. After two years, i sold the property for RM 1.2 Mil. Assume also that the purchase was 100% financed with my cash.

The return on asset@ ROA is (RM 1,2 Mil minus RM 1.0 Mil) / 2 = RM 100,000, or a 20% return.

The return on investment@ ROI is:

ROI = [ Rental x 12] + [RM 1.2 Mil - RM 1.0 Mil ] / RM 1.0 Mil

= 26% ( This is a Holding period return)

= 12.25% an annum

Scenario 2 :

Let's assume that all other facts provided in scenario one above remains, except that this time i decided to finance a part of the purchase price with a borrowed fund from a local financial institution; say 10% of my own cash, and 90% of borrowed money@ 7% interest.

That means my initial investment is only RM 100,000 @ deposit money.

The ROA remains the same.

The ROI is:

ROI = [Rental x 12] + [RM 1.2 Mil - RM 1.0 Mil] - [ {RM 900,000@7%} x 2]

= RM 134,000 / RM 100,000

= 134% ( This is a holding period return)

= 52.97% per annum

So, there you are!! It is always a better option to go for gearing to purchase high net worth rental properties.